Freddie Mac 2009 Annual Report Download - page 206

Hedge Forecasted Debt Issuances and Create Synthetic Funding
We regularly commit to purchase mortgage investments on an opportunistic basis for a future settlement, typically
ranging from two weeks to three months after the date of the commitment. To facilitate larger and more predictable debt
issuances that contribute to lower funding costs, we use interest-rate derivatives to economically hedge the interest-rate risk
exposure from the time we commit to purchase a mortgage to the time the related debt is issued. We also use derivatives to
synthetically create the substantive economic equivalent of various debt funding structures. For example, the combination of
a series of short-term debt issuances over a defined period and a pay-fixed swap with the same maturity as the last debt
issuance is the substantive economic equivalent of a long-term fixed-rate debt instrument of comparable maturity. Similarly,
the combination of non-callable debt and a call swaption, or option to enter into a receive-fixed swap, with the same
maturity as the non-callable debt, is the substantive economic equivalent of callable debt. These derivatives strategies
increase our funding flexibility and allow us to better match asset and liability cash flows, often reducing overall funding
costs.
Adjust Funding Mix
We generally use interest-rate swaps to mitigate contractual funding mismatches between our assets and liabilities. We
also use swaptions and other option-based derivatives to adjust the contractual funding of our debt in response to changes in
the expected lives of our mortgage-related investments. As market conditions dictate, we take rebalancing actions to keep
our interest-rate risk exposure within management-set limits. In a declining interest rate environment, we typically enter into
receive-fixed swaps or purchase Treasury-based derivatives to shorten the duration of our funding to offset the declining
duration of our mortgage assets. In a rising interest rate environment, we typically enter into pay-fixed swaps or sell
Treasury-based derivatives in order to lengthen the duration of our funding to offset the increasing duration of our mortgage
assets.
Types of Derivatives
The derivatives we use to hedge interest-rate and foreign-currency risk are common in the financial markets. We
principally use the following types of derivatives:
• LIBOR- and the Euro Interbank Offered Rate, or Euribor-, based interest-rate swaps;
• LIBOR- and Treasury-based options (including swaptions);
• LIBOR- and Treasury-based exchange-traded futures; and
• Foreign-currency swaps.
In addition to swaps, futures and purchased options, our derivative positions include the following:
Written Options and Swaptions
Written call and put swaptions are sold to counterparties allowing them the option to enter into receive- and pay-fixed
swaps, respectively. Written call and put options on mortgage-related securities give the counterparty the right to execute an
interest rate swap contract under specified terms, which generally occurs when we are in a liability position. We use these
written options and swaptions to manage convexity risk over a wide range of interest rates. Written options lower our overall
hedging costs, allow us to hedge the same economic risk we assume when selling guaranteed final maturity REMICs with a
more liquid instrument and allow us to rebalance the options in our callable debt and REMIC portfolios. Potential losses on
written options are unlimited. We have limits in place to mitigate our written option exposure and our daily rebalancing
activities further minimize this exposure. We may, from time to time, write other derivative contracts such as caps, floors,
interest-rate futures and options on buy-up and buy-down commitments.
Forward Purchase and Sale Commitments
We routinely enter into forward purchase and sale commitments for mortgage loans and mortgage-related securities.
Most of these commitments are derivatives subject to the requirements of derivatives and hedge accounting.
Swap Guarantee Derivatives
We issue swap guarantee derivatives that guarantee the payments on (a) multifamily mortgage loans that are originated
and held by state and municipal housing finance agencies to support tax-exempt multifamily housing revenue bonds and
(b) Freddie Mac pass-through certificates which are backed by tax-exempt multifamily housing revenue bonds and related
taxable bonds and/or loans. In connection with some of these guarantees, we may also guarantee the sponsor’s or the
borrower’s performance as a counterparty on any related interest-rate swaps used to mitigate interest-rate risk.
Credit Derivatives
We enter into credit derivatives, including risk-sharing agreements. Under these risk-sharing agreements, default losses
on specific mortgage loans delivered by sellers are compared to default losses on reference pools of mortgage loans with
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